Inflation chained CPI vs cpi growth of $10000

Last week, before Washington gave up on solving the Fiscal Cliff before Christmas, Obama made an offer to Republicans that included a small reform to Social Security. The system allows for a cost of living adjustment every year, and this is based on the Consumer Price Index. The change alters how the cost of living adjustment (COLA) is calculated. Instead of CPI, it would use the Chained CPI.

The Consumer Price Index is the main measure of inflation in the US. It tracks prices of over items in over 200 categories. They range from cereal and coffee, to sweaters and jeans, to pet toys and sports equipment, to tobacco and funerals. The goal is to cover everything we can expect to pay for in our normal lives. It does not cover costs associated with investments and savings, like insurance and real estate. These costs are all monitored via economic assistants that manually track these prices at stores, merchants, and other establishments all over the country. They log 80,000 items each month to track how prices are changing.

The CPI is a constantly weighted. So they don’t change the balance or score of how much each price contributes to the report based on changes in shopping habits. That’s where the Chained CPI comes in. Chained CPI makes adjustments for the substitute goods we might purchase if prices climb on something we might normally buy. For example, if the price of beef rises we might buy more chicken instead. Or, if plane tickets go up we decide to drive instead. So which one is more accurate?

I’ll let Slate offer some perspective:

 “There is genuinely no right or wrong about the question of which is “the best” index to use. To the extent that you want to insulate people from the need to make lifestyle compromises in response to price increases, you should use the unchained CPI. To the extent that you don’t, you should use the chained CPI”

The fundamental difference is that because we substitute goods when prices go up, the Chained CPI rises more slowly than CPI. And now that Obama has proposed the use of Chained CPI as a part of fiscal cliff negotiations it can only mean that he must hate old people. Republicans will be pleased that he’s even putting entitlements on the table. Because they weren’t a part of the fiscal cliff before, senior groups and liberal Democrats are not happy about the proposal.

However this is something that will have an impact on our deficit. It will reduce payouts slightly. As you can see in the chart above it may not be much, but after a decade or two of retirement it’s enough to feel. It’s up to you to decide if you think the change is appropriate. While it will reduce the deficit, it won’t fix Social Security. A true benefit reduction in the form of higher retirement ages is the only thing that will really change to course of entitlements. If you haven’t read my post on Social Security and retirement age you really should. Until things such as this are addressed moves such as Chained CPI instead of CPI are merely sweeteners in larger negotiations. It’s not reform.

categories: government, personal finance